Reviewing Center Stage at This Year's Halftime Show

As we cross the halfway mark of 2013, it has so far been an interesting year to say the least. Early in the year, investors shook off fears of sequestration, or the mandated federal budget spending cuts, and by springtime had pushed U.S. equities to double digit returns. They were cheering Ben Bernanke and his colleagues at the Federal Reserve over their injection of massive amounts of liquidity into the financial markets as a possible way to boost economic growth. If this massive liquidity was driving markets higher, few questioned what would happen when the Fed stopped.

As the adage goes, all good things must come to an end. Given signs that economic growth was picking up, Bernanke in late May said the Federal Reserve could decide to reduce the pace of its bond purchases (i.e. liquidity into the financial markets) "in the next few meetings." Like a rug being pulled out from under the feet of investors, these comments regarding tapering quantitative easing (QE), which investors have come to call the Fed's massive liquidity efforts, roiled financial markets. Nearly every investment dropped including stocks, gold, silver, and oil. In fact, the only investment bucking the trend was bond yields. For example, the yield on the 10-year U.S. Treasury rose 59 basis points in 30 trading days, the largest rise in yields in over two years. Unfortunately, since bond yields move inversely to price, the jump in yields was the result of a sharp selloff in the bond market. Once the dust settled, stocks seemed to have found their footing as recent market moves have been more to the upside.

For the balance of this year, investors are likely to continue to struggle with the prospects for a tapering of QE and a potential further rise in interest rates. With that said, QE is not the only reason the stock market has performed well this year. Strong corporate earnings have played a role too. Earnings growth for the S&P 500 companies has been strong since the end of the 2008 - 2009 recession and still, as of recently, analysts' expected earnings for the major equity indices remain at all-time highs. Despite the recession in Europe and weaker growth in the emerging markets, large-cap U.S. corporations have found ways to make and grow profits, benefiting stock prices.

In general, rising interest rates in the context of strong earnings growth are less worrisome than they would be in the face of declining earnings or weakening economic growth. The consensus economic outlook for the United States, with which we broadly agree, is for continued slow growth that will accelerate gradually to a trend-like 3% real GDP growth rate by the end of 2014. The main drivers of this growth are the housing sector, that continues to recover, and consumer spending that continues to hold up.

In this environment of slow but improving global growth, we continue to suggest equity allocations in line with investment objectives. Within equities we are biased toward domestic stocks and larger capitalization companies. In fixed income, we feel it may be a mixed bag. We are leery of long-term Treasuries, where despite the recent rise in yields, prospective returns do not compensate for risks, in our view. The main risk is that the market overreacts to the winding down of QE. While central bankers often promise to change policy gradually, events have a way of unfolding in anything but a gradual manner. The risk that inflation picks up suddenly and the Fed has to slam on the brakes, meanwhile, cannot be ruled out altogether, though that is not our base case scenario. On the other hand, bonds that trade at a yield spread over Treasuries, such as corporate bonds, did not fare well in the Fed's comments sell-off but we continue to believe that they will be in a better position to weather any turbulence in the bond markets. Throughout portfolios, we continue to stress income generating investments and increased diversification.

This information compiled by Cetera Financial Group is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment.

No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular news update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly in indices. This is not an offer, recommendation or solicitation of an offer to buy or sell any security and investment in any security covered in this material may not be advisable or suitable. Please consult your financial professional for more information.

While diversification may help reduce volatility and risk, it does not guarantee future performance. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.

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